In a recent report by Wharton Social Impact Initiative & Knowledge@Wharton on Innovative Finance and the various forms it has taken, the report highlights among others, the multi-originator securitization (MOSEC) transaction that was first pioneered by IFMR Capital. Tracing the origins of MOSEC and how the idea, brought about by an underlying frustration at not being able to cater to small but high-quality originators, came into being. The article throws light on what has since been one of the key vehicles for IFMR Capital in its endeavour to enable capital access to partner originators that it works with.

From the article:

In June 2008, IFMR Capital, a non-bank financial company based in Chennai, India, had opened its doors with the express purpose of providing access to the financial markets to the millions of Indians who lacked it. But, the small- and medium-sized originators who were making loans to the population that IFMR Capital wanted to serve were constrained by the sizes of their businesses.

IFMR had been trying to persuade investors to buy some of the debt of these small microfinance institutions so they could make more loans. But investors were wary. They feared the risk from loans from a single small originator from just one area of the country that was possibly subject to the same natural disasters.

“They were very high quality originators, but they were very small. They were not ready to go to the capital markets,” says Mukherjee, who was CEO of IFMR Capital at the time and is now CEO of IFMR Holdings.

Finally, Mukherjee, deliberating with her colleagues, blurted out, “Why don’t we just pool?” What she was suggesting, securitizing the loans of small- and medium-sized microfinance institutions, originators with portfolios as small as $500,000, had never been tried.

In January 2010, a little more than a year after Mukherjee asked the question, IFMR issued its first multi-originator securitization (MOSEC, now trademarked), a $6.5 million issue bundling some 42,000 microloans, with an average size of $200, from four originators. To date, IFMR has issued 89 MOSECs for microloans worth more than $675 million, representing some 3.7 million loans securitized.

Using a similar model, it has done another $2 billion of MOSECs of affordable housing, small business and agricultural loans. The securitizations give the microfinance institutions access to low-cost capital at a price some 200 to 250 basis points lower than what they’d had previously, and to a new group of investors, including mutual funds, private banks and high-net-worth individuals.

Crucial to turning the idea into action was the special combination of people around the table at IFMR, says Mukherjee. Besides herself, with years of experience in structured finance at Morgan Stanley and Deutsche Bank, was Kshama Fernandes, then chief risk officer of IFMR Capital and now CEO of IFMR Capital, who had deep experience in Indian banking and was a well-known figure who provided credibility to their at-the-time unknown institution; Bindu Ananth, the president of IFMR Trust, whose idealism was essential to making the group press on and tackle problems rather than being discouraged by obstacles; and Gaurav Kumar, the head of origination, who intimately knew the individual lenders and the details of their business and could vouch for their creditworthiness.

“There was nothing in the law that actually prevented it. It was an innovation waiting to happen,” says Mukherjee. “At the end of the day, you apply the same tools and principles of diversification (you’ve done in the past). What we did was contribute to the learning in developing our own underwriting standards for microfinance and small business lenders. What we brought was discipline, expertise, and we became the expression for self-confidence for these asset classes.”

The securitizations have now become so commonplace that they are no longer considered innovative. However, IFMR remains alone in both structuring the deals and retaining a portion of the debt on its own books, says Mukherjee. That way, IFMR ensures that interests are aligned and that the deals are designed for long-term profitability and sustainability, she says.

In the latest edition of The Euromoney Securitisation & Structured Finance Handbook 2014/15 (published by the Euromoney Handbooks, London) Sreya Ray & Vaibhav Anand of IFMR Capital have authored a chapter on the topic of Mortgage backed securitisation for affordable housing finance. In the chapter the authors provide a perspective on affordable housing finance and the challenges that it faces, along with an appraisal framework for AHFCs. In addition they detail a case study of IFMR Capital’s first ever mortgage backed securitisation for an AHFC.

Excerpt:

Affordable Housing Finance Companies (AHFCs) in India have emerged as a small but fast-growing segment committed to addressing the credit gap in the mainstream financial system for low-income households seeking mortgage finance. These AHFCs have overcome the challenges in credit appraisal of undocumented cash flows of low-income borrowers through a deep and localised understanding of the informal economy and innovative models to evaluate the financial position and creditworthiness using non-traditional data points. Given this non-traditional approach to credit appraisal, these AHFCs face challenges in accessing debt that they can then on-lend to their potential borrowers. Access to capital markets via securitisation can be a very effective tool to provide efficient, reliable and sustainable sources of funds for AHFCs on a maturity matched basis, provided the legal complexities and risks of a mortgage-backed securitisation (MBS) can be adequately managed. IFMR Capital pioneered the first ever MBS for an AHFC, Hebros AHL IFMR Capital 2014, on March 27, 2014, leading the way for AHFCs to enter capital markets.

As a follow-up to our earlier post where we had talked about our first securitisation in the Commercial Vehicle (CV) Finance space, in this post we briefly provide an overview of the industry and discuss the key risk factors affecting the CV industry along with factors that impact the performance of a portfolio of CV loans.

Overview

Commercial Vehicle (CV) industry in India has surged over the past decade and the market is expected to grow at a CAGR of over 15% until 2016 (Source: Society of Indian Automobile Manufacturers (“SIAM”)) with many companies competing to expand. Commercial vehicle is a type of motor vehicle that is used for transporting goods or carrying passengers with former contributing around 87% in India. Commercial vehicles are classified into Light, Medium & Heavy depending upon its gross vehicle weight. The CV industry enables quick, easy departure of goods and accepts smaller loads than railways and also commercial vehicles can access remote and hilly areas where rail lines cannot be constructed.

The main growth drivers for CV Industry are modernisation of the trucking industry, structural shift to Hub & Spoke model, improved road infrastructure, growing freight capacity and increase in exports from remote areas enabling the producers/manufacturers to move their goods to ports. The key risk factors for this industry are low freight demand and truck rentals, non-availability of cargos, fuel price, risk prone area of occupation, sudden transport strike, competition with alternate mode of transport (Railways) and any new government regulations related to restrictions based on age of the vehicle and other environmental safety issues. Also, recent study on CV industry by ICRA found that the India’s GDP and IIP numbers are very closely correlated with the development of Commercial Vehicle Industry, which in turn has made this industry the lifeline of Indian Economy.

CV Financing and Securitisation

CV Financing Industry in India has seen an impressive growth and in the last five years till 2012-13, CV loan disbursements grew by around 11 per cent (Source: CRISIL Research, Retail Finance- Auto, June 2013). Major players in CV Financing in India are Tata Motors Cholamandalam Finance, Sundaram Finance, AU Finance, Shriram Transport Finance, Magma, L&T, M&M and Religare. The key factors that could impact vehicle financing in India are growth in vehicle sales, finance penetration and average ticket size (players offering marginally higher LTV because of competition from other players). The process of pooling the loans given by these CV financiers and selling the securities backed by cash flows from the loans to investors is termed as ‘Securitisation’ of CV pools and the bank or finance company that has originated the pool of receivables/loans is termed as ‘Originator’. While selecting the loans for securitisation, Originator should take into account the factors such as loan tenure, Interest rates, vehicle type (LCV/UCV), geographical diversity, recovery rates, etc.

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Risk Factors affecting the CV portfolio performance

We performed a small study to identify the factors that significantly affect the Securitised CV pool performance (delinquencies) and have illustrated the way in which these factors affect the delinquencies.

Data was collected from the Pool Performance reports (from Jun’ 08 to Dec’12) published by Rating Agencies (CARE, ICRA and CRISIL) with a total number of 194 transactions of 14 different Originators. The factors, which could affect the pool performance, were identified based on three broad categories such as Transaction Details, Initial Pool Details and Pool Performance Details. Once data and factors were identified, regression of these factors with 90+ and 180+ delinquencies was performed and the significance level of factors affecting the delinquencies was observed.

We found that originators have greater impact on delinquencies than any other factor. This implies that the characteristics and business model of originator seems to be the most important deciding factor for the CV pool performance. Even though none of the coefficients of other pool parameters are found to be significant, certain parameters like presence of new CV (NCV) in the pool, weighted average seasoning of the pool and ticket size of the loans seem to have positive impact on pool performance. However, the single regression results do not consider the inter dependencies between the factors. For example, presence of NCV in the pool and high-ticket size of the loans can go hand in hand. Further, an originator may spend significantly more effort in the credit evaluation of a high-ticket loan resulting in better origination.

IFMR Capital recently closed its first securitisation deal in the commercial vehicles finance sector in India. The transaction marks a significant event for IFMR Capital as it represents its foray into commercial vehicles securitisation. It is also yet another instance of IFMR Capital taking an originator to the securitisation markets for the very first time.

The transaction – Protos IFMR Capital 2013 – was backed by a loan pool of Rs.185 Million originated by EssKay Auto Finance Private Limited, a company based in Jaipur with operations in Rajasthan and Gujarat. EssKay primarily provides loans to first time buyers and small transporters for purchase of used vehicles. A large number of borrowers are owners cum drivers. The underlying pool in the Protos IFMR Capital transaction was a mix of used LCV, MUV, HCV and three wheelers that typically ply in the shorter haul and transport agricultural and other goods for local consumption.

The SPV (Special Purpose Vehicle) issued two tranches of PTCs (Pass Through Certificates). The senior tranche was rated A- (SO) by ICRA. Hinduja Leyland Finance, a leading NBFC providing commercial vehicle finance, invested in the senior tranche. True to its mission of providing capital markets access to high quality institutions that impact the financially excluded and aligned in its role as structurer, arranger and investor, IFMR Capital invested in the subordinated tranche of the transaction.

“In a very short span of time, we have grown comfortable working with the IFMR Capital team. We appreciate their analysis and insights, and how they have represented us to external investors and the capital markets. We definitely hope for more of this in the months to come, and look forward to many more transactions.” Mr. Rajendra Setia, MD, EssKay Auto Finance Private Limited said on their first securitisation transaction.

Commenting on the landmark deal, Dr. Kshama Fernandes, CEO, IFMR Capital, said, “This transaction is a great demonstration of how our understanding of risks has evolved from one asset class to another, all the while keeping the core of our investment philosophy unchanged.”

Over 2006-12, RBI and SEBI have created a strong and conducive regulatory environment for securitisation, listing of securitised debt instruments, and standards of transparency and reporting. Securitisation volumes have picked up and we recently witnessed the first listed transaction.

In October 2011, the income tax authorities issued a claim on certain securitisation special purpose vehicles (SPVs), stating that the gross income of such SPVs was liable to tax. The matter is presently under sub judice with the Bombay High Court. Several industry participants approached the Ministry of Finance (MoF) to seek clarity and reinforce the “pass through” status of a securitisation SPV.

The Finance Bill, 2013, has sought to clarify the tax position by stating that securitisation SPVs are not liable to pay income tax. However, the Bill also states that trustees of such SPVs must pay tax on distributed income.

The above amendment has an unintentional and significantly negative implication, on account of which taxable investors would be disincentivised from participating in securitisations.

This memo explains the issues and the unintended implications caused by the present draft of the Finance Bill in relation to securitisation SPVs, and provides a possible solution for addressing these issues.